Certified Financial Management Specialist Practice Exam

Which type of ratio would you use to determine how well a firm can cover its short-term liabilities?

1. Liquidity ratios

2. Market value ratios

3. Profitability ratios

4. Debt management ratios

The correct answer is: Liquidity ratios

Liquidity ratios are specifically designed to assess a firm's ability to meet its short-term obligations, making them the appropriate choice for determining how well a firm can cover its short-term liabilities. These ratios, such as the current ratio and quick ratio, measure the company’s available liquid assets in relation to its short-term debts. For instance, the current ratio compares current assets to current liabilities, indicating whether the assets a company holds can effectively cover its short-term liabilities. A higher current ratio suggests a stronger liquidity position, meaning the firm is in a better position to respond to short-term financial obligations. In contrast, market value ratios focus on the firm’s overall market value relative to financial metrics, often used to gauge investment potential, but do not provide insights into short-term liabilities. Profitability ratios are concerned with a company’s ability to generate profit relative to sales, assets, or equity, thus not relevant to short-term liability coverage. Debt management ratios analyze the company’s capacity to manage its long-term debt and financial leverage, which are also not focused on short-term liabilities.